Trade Offs and Opportunity Cost
The reality of scarcity is the conceptual foundation of economics. Understanding scarcity and its implications for human decision-making is critical to economic literacy – but that understanding isn’t easily achieved. Like many academic disciplines, economics has its own language, in which the definition and usage of familiar terms – like scarcity – differ from those of everyday speech, and even from one discipline to another. This lesson develops the definition and implications of living in a world of relative scarcity in which people must choose between alternative sets of benefits. Further, it introduces the Production Possibilities Frontier, a visual model of the costs and benefits of choosing one alternative over another.
Standard 1: Students will understand that: Productive resources are limited. Therefore, people cannot have all the goods and services they want; as a result, they must choose some things and give up others.
- Scarcity is the condition of not being able to have all of the goods and services one wants. It exists because human wants for goods and services exceed the quantity of goods and services that can be produced using all available resources.
- Like individual, governments and societies experience scarcity . . . .
- Choices involve trading off the expected value of one opportunity against the expected value of its best alternative.
- The evaluation of choices and opportunity costs is subjective; such evaluations differ across individuals and societies.
Standard 2: Students will understand that: Effective decision making requires comparing the additional costs of alternatives with the additional benefits. Most choices involve doing a little more or a little less of something; few choices are all-or-nothing decisions.
- Marginal benefit is the change in total benefit resulting from an action. Marginal cost is the change in total cost resulting from an action.
- As long as the marginal benefit of an activity exceeds the marginal cost, people are better off doing more of it; when the marginal cost exceeds the marginal benefit, they are better off doing less of it.
Standard 3: Students will understand that: Different methods can be used to allocate goods and services. People, acting individually or collectively through government, must choose which methods to use to allocate different kinds of goods and services.
Students will be able to use this knowledge to: Evaluate different methods of allocating goods and services by comparing the benefits and costs of each method.
- Scarcity requires the use of some distribution method, whether the method is selected explicitly or not.
- Comparing the benefits and costs of different allocation methods in order to choose the method that is most appropriate for some specific problem can result in more effective allocations and a more effective overall allocation.
- Define scarcity as the fundamental economic condition, and provide examples of the importance and implications of relative scarcity.
- Develop the logic that leads from scarcity to the necessity of choice. Illustrate how the economic condition forces everyone – consumers and producers – to make choices.
- Discuss how societies devise different systems of allocation to systematically address the necessity of choice.
- Demonstrate the subjectivity of distinctions between needs and wants.
- Discuss how allocation systems help people make choices. .
- Illustrate the concepts of trade offs and opportunity cost.
- Introduce and practice the production possibility frontier model of trade-off and opportunity cost.
- Introduce marginal decision making. Illustrate the power and clarity that marginal cost / marginal benefit analysis brings to individuals’ choice making.
- Illustrate and explain how economists distinguish between good choices and poor choices.
- Further develop the “economic way of thinking” by illustrating the variety of problems at can be addressed with reasoning based on understanding of foundational economic concepts like scarcity, choice, cost, and incentives.
- Ask and answer the question: “What value is the economic way of thinking to me?”
- We live in a world of relative scarcity.
- Scarcity exists when resources have more than one valuable use.
- Scarcity exists even in the midst of abundance.
- Scarcity forces people to choose between alternatives.
- People choose purposefully from the alternatives they perceive.
- Individuals’ evaluation of alternatives is subjective.
- Scarcity is dealt with more effectively by recognizing that the distinction between needs and wants is subjective.
- Societies have adopted a variety of allocation systems to deal with scarcity.
- The opportunity cost of choosing one alternative is the value given up by not taking advantage of the next best alternative.
- To choose is to refuse: the decision to take the benefits of one alternative means refusing the benefits associated with the next-best opportunity.
- Good decision-making occurs at the margin.
- We seldom make all-or-nothing decisions; everyday life is an exercise in marginal decision-making.
- Decisions to continue or discontinue an activity are made by weighing the additional expected benefits against the additional expected costs.
- The PPF (Production Possibility Frontier) models the trade-offs and opportunity costs that necessarily accompany decision-making in the face of scarcity.
- Scarcity is more of a problem for the poor.
- People face scarcity; governments do not.
- Producers make choices differently than consumers.
- We can have more without giving up anything.
- Good choices don’t have costs.
- Good decision-making means being able to distinguish between good and bad alternatives.
- Sometimes, you just have no choice.
- Once a choice is made people must stick to it. Once you’ve made a choice, you should stick to it.
- Marginal analysis is an economists’ tool and is rarely used in everyday life.
- The value of an education is an exclusive personal benefit.
- Economic choice making principles work better for western societies. The principles of economic decision-making (opportunity cost and marginal analysis) don’t work in non-western cultures.
Frequently Asked Questions:
- How can something be scarce and not in short supply at the same time?
- How can it be that rich people face as much scarcity as poor people do?
- Does finding more productive resources make things less scarce?
- The words “price” and “cost” are used interchangeably in everyday speech. Why, in economic terms, is the price of a good or service different than its cost?
- How can you give up something you never had in the first place? (opportunity cost)
- How can it be wise to take the time and effort to make a well-considered choice and then not follow through on it?
- Is the production possibility curve ever a straight line?
Classroom Activity Options
- Distribute and discuss the article entitled Scarcity.
- Have students participate in a ‘real’ allocation simulation.
- Bring in an item to use for the simulation – a large cinnamon roll for a morning class, or a gourmet chocolate bar for an afternoon class – something you know many students will want.)
- Show the item to the students and tell them you have an ‘economic problem.’ You didn’t have enough money to buy the item for everyone, so you want them to determine how it is to be distributed.
- Give them 5 minutes to work in groups of 2 or 3 to brainstorm and list as many ways to distribute the item as possible.
- Re-convene the large group and, in round-robin fashion, list distribution methods on the overhead or whiteboard, until no new ways are proposed. (Do not allow discussion during this time, only the listing of the distribution types.)
- Group the list items into (standard) categories of allocation systems: auction, contest, equal/sharing, need, merit, arbitrary characteristics, someone decides, lottery, price, etc.
- Solicit student evaluation (in small groups or with class as a whole) of the advantages/disadvantages of each distribution method.
- Once this exercise is completed, tell students they now have the knowledge they need to make an informed decision and that they will get one vote each to determine how the item will be distributed.
- Conduct the vote. (In most all cases a ‘no pay’ lottery will be selected even though the students will have been very sympathetic for the categories of ‘need’ and ‘equity’ in the distribution process.)
- Distribute the item as selected by the class.
- Then, tell the class that what they just did is reflective of economies throughout the world.
- Go through each method they recommended and have them provide examples of ‘real life’ distribution in that manner —- e.g. those over / under certain ages may get price breaks in restaurants or hotels or movies.
- Assign the students with the task of identifying the cost to them of each of the following choices:
- buying a $10,000 used car
- going to a movie with friends next Thursday night
- going steady with Jim or Jane
- going out for a varsity sport
- the opportunity cost is the next-best alternative, not all the possibilities
- because people’s values differ, the opportunity cost of the same decision may differ from person to person
- Ask students to brainstorm a list of the choices they make each morning in coming to school. For each choice, identify the next-best alternative. (Example: First choice of the morning: Get up when the alarm goes off. Alternative: Turn off the alarm and go back to sleep. Second choice of the morning: Take a shower. Alternative: Go back to bed. etc.) Emphasize that the value of the next-best alternative is the opportunity cost of each decision.
- Ask students if they will stay in school until graduation. Ask them what could make them change their minds – either from yes to no, or from no to yes. Emphasize that deciding whether or not to keep coming to school is a marginal decision. Each day, students weight the expected additional costs and expected additional benefits of going to school again, and if those expected additional costs or benefits change, then their decision about staying in school until graduation may change.
- Display the big pencil and discuss all of the choices that must be made and by whom in order to produce it. Identify the productive resource categories and why these are scarce. Introduce the incentives that cause the pencil to be produced.
- Distribute the Thomas Sowell article entitled “Why Economists Are Not Popular.” Discuss why economists are so concerned about costs. Obtain a two pan balance and use this prop to visually reinforce the decision-making process of weighing expected costs with expected benefits.
- Distribute practice PPF problems for students to work on individually or in small groups. Ask students to generate original PPF examples demonstrating trade-offs and opportunity costs from their own lives.
- Ask students to discuss the question of how an understanding of opportunity cost could change their own lives.
Handouts and Supplemental Materials
- “Why Economists Are Not Popular,” by Thomas Sowell. The Tampa Tribune, April 7, 2002.
- “Identifying Needs” and “Identifying Needs – Again”
- “Trade-Offs and Opportunity Costs”
- “Adam and Eve”
Directions: Place Xs in the blanks next to NEEDS in the list below.
_____ Health Care
Identifying Needs – Again
Directions: Place Xs in the blanks next to NEEDS in the list below.
_____ Campbells Pork and Beans
_____ Apt. 210, 1505 Garfield Ave.
_____ Coleman Oasis Tent
_____ Orville Redenbacher popcorn
_____ Levi’s jeans
_____ high school diploma
_____ Purdue University B.A. degree
_____ Nokia cell phone
_____ Dr. West, Obstetrician
_____ Texaco unleaded gasoline
_____ Ford Focus
TRADE OFFS AND OPPORTUNITY COSTS
- Anchor the concept in real life experience for student
- Graphs and Math SUPPORT the intuitive reasoning behind economic thinking.
- Most economic concepts are repetitive and used in a variety of application as we build the economic way of thinking
- Know the key concepts very well!
- Economics has specific language/vocabulary … sometimes we use different words to get at the same concept.
- Have some fun.
- Ask and answer the rhetorical question: “What value is it to me?”
Anchor the concept of OPPORTUNITY COSTS:
What could you be doing instead of being here for this session?
(List your alternatives here.)
What is your opportunity cost for being here for the next hour?
How do economists use the concept of opportunity cost to explain a person making a mistake?
What is the Opportunity Cost for a high school student to study one hour for Economics?
What will confuse your students?
- Opportunity Cost isn’t everything you give up . . . just the most-valued (“next-best”) thing
- Opportunity Cost helps explain all human behavior, not just behavior in business or markets.
- Opportunity Cost is a concept that is utilized in many applications in economics (like the reason for trade), and the basic idea DOES NOT CHANGE.
- Opportunity Costs are half of the story of CHOICE.
ADAM and EVE
In the beginning there was a production possibility frontier.
|Adams’s PPF||Eve’s PPF|
1. Plot Adam’s and Eve’s PPFs
- What might cause a change in Adam and/or Eve’s productive capacity?
- What might cause a decrease in productive capacity?
We will continue the story of Adam and Eve in a later session.
Economics builds on ideas!